Published: March 13, 2013 at 9:13 am

There are numerous companies in the world who have turned from rags to riches, and again to rags. Hewlett-Packard Company (NYSE:HPQ) is one of those names. It was once the market leader in the tech world, then lost its way through a flurry of bad multi-billion dollar acquisitions, and also lost the innovative culture that had made it what it was in its glory days. I believe in the coming two years we might see a handsome turnaround story. Let’s assess why.

Attractive valuation and dividend yield.

Hewlett-Packard Company (NYSE:HPQ) trades at less than 5 times expected 2013 non-GAAP earnings, and there is little doubt that its earnings are cyclically depressed. It has an attractive forward PE of 4.9.

I think the main reason people may consider HP as an investment is not only because of its relatively low financial risk, but also its relatively high dividend yield. As of recent quarter, HP paid a quarterly dividend of $0.13, which is nearly a 3.09% annual dividend yield. In comparison, Xerox Corporation (NYSE:XRX)is offering a dividend of $0.04 per share, which reflects a yearly yield of 2.19%.

But for Xerox, the risk attributed to the dividend payment is higher than that of HP. The free cash flow of these companies (calculated by the sum of operating activities and investing activities cash flow) is negative or nearly zero. In the first nine months of 2012 the free cash flow of Xerox reached $206 million, which is barely enough to cover the company’s $195 million dividend payment.

Decent Q4 and healthy cash flow.

First quarter non-GAAP diluted earnings per share of $0.82 were down 11% from last year, but were above the previous outlook of $0.68-$0.71. First quarter GAAP diluted earnings per share were $0.63, down 14% from the prior year, but above the previous outlook for $0.34 to $0.37 per share. Net revenue in the quarter was down 6% YoY to $28.4 billion, and down 4% when adjusted for the effects of currency.

Hewlett-Packard produced $2.6 billion of cash flow from operations, which was up 115% YoY. $2.1 billion of free cash flow was generated in the quarter, highlighting the underlying profitability of Hwelett-Packard’s business mix.

Hewlett-Packard continued returning capital to shareholders, having spent $511 million in the quarter on dividends and buybacks. Hewlett-Packard is intelligently guiding conservatively into 2013. The company estimates second quarter non-GAAP diluted EPS to be in the range of $0.80 to $0.82, and GAAP diluted EPS to be in the range of $0.38 to $0.40. In the first quarter, Hewlett-Packard Company (NYSE:HPQ) paid a $0.132 per share dividend that resulted in cash usage of $258 million, and the company also bought back 19.2 million shares for roughly $253 million.

That equates to an average price of $13.17, and is an exceptional utilization of cash. Shares outstanding were down to 1.956 billion from 1.964 billion on Oct. 31, and 1.998 billion at the same time last year. Hewlett-Packard Company (NYSE:HPQ) continues to improve its net debt situation by reducing it by more than $1 billion in the quarter to $4.7 billion, and this marks the fourth consecutive quarter where the company has been able to reduce net debt.

Positive future ahead

Microsoft (NASDAQ:MSFT)’s release of Windows 8 has given a huge boost to the PC industry because it has integrated a UI (Metro) designed for touch-screen use into Windows 8, the result of which is we are seeing mass upgrades to touch-enabled laptops and desktop, thus increasing PC upgrade profits. The PC business is extremely cash generative, and is absolutely essential for assisting sales of the potentially lucrative service offerings.

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